Last week, the Obama Administration decided not to implement the Community Living Assistance Services and Supports (CLASS) Act. This Act authorized the Department of Health and Human Services (DHHS) to sell a low price/limited benefit long term care insurance (LTCI) plan, provided that the plan would be actuarially sound. The Act also required DHHS to perform a 75 year financial projection. After a year of analysis, DHHS concluded that there was the plan could not cover its costs and so it pulled the plug on CLASS.
I first learned about CLASS when I was asked by a senior economist in DHHS to provide a strategic assessment of the business prospects for CLASS. DHHS officials were appropriately concerned that the low price/limited benefit plan would almost surely suffer from adverse selection and end up losing money. So they wanted to know whether CLASS could offer additional LTCI plans to cover the losses in the base plan. I persuaded Cory Capps (a former colleague and partner with BatesWhite, an economic consultancy) and Leemore Dafny (my current colleague at Northwestern) to help with the analysis. We shared ideas with economists working within DHHS.
We viewed this as a traditional market analysis. Anyone can enter a market and lose money – the base CLASS plan would be a poster child for this obvious point. We wanted to understand whether there were any opportunities to turn a profit in the LTCI market. We also wanted to understand why, if there are profits to be had, private insurers had not already exploited these opportunities?
What we found was a rather strange market. There are lots of LTCI sellers, mostly crossovers from the life insurance market. This makes sense, because the main purpose of LTCI is to help enrollees preserve their retirement savings. The same customer who buys life insurance to make sure their next of kin are well taken care of would therefore also want to buy LTCI. These customers trust life insurers, most of whom have been around for a century or longer and can be counted on to pay out future benefits. At the same time, LTCI products are remarkably (perhaps unnecessarily, and likely strategically) complex, so customers rely on their insurance brokers to explain their options. These features helped mute competition among LTCI insurers and possibly pose entry barriers to new sellers.
We were reasonably convinced that CLASS could rely on the reputation of the federal government to assure future payouts. (We would have been more convinced a few years ago.) And the CLASS Act provided DHHS with a chance to work around the broker market – employers would be given the option to offer CLASS LTCI to their employees, although it was not clear if employers would be eager to participate. So it seemed that DHHS could overcome the two main barriers to entry.
With the wind in our sails, we addressed the most critical questions: What products would DHHS sell? How would it penetrate the market? Could these products survive competitive forces? We immediately rejected the idea of offering the same products sold by private LTCI firms. If DHHS sold the same products that were already on the market, private insurers would surely match on price and the market would have to expand to accommodate CLASS insurance. This was a risky prospect, as private insurers had been trying to grow the market for years with very limited success.
Putting on our strategy hats, we wondered if DHHS could come up with new product features, thereby attracting a broader base of enrollees. Exchanging ideas with DHHS economists, we came up with quite a few suggestions: tontines (where enrollees enjoy rebates of premiums if they don’t end up needing LTC), extended vesting periods before coverage began, “short term” LTCI and others. We laid out the advantages and disadvantages of each feature and we asked a critical strategy question: If these features are so promising, why aren’t private LTCI insurers offering them? For some features, such as the extended vesting period and the tontine, we were reasonably sure that DHHS could secure a profitable niche in the market. Even so, we wondered how these ideas would be explained to consumers. LTCI insurers relied on brokers. Who would get the word out for CLASS?
On balance, we were rather optimistic about the potential success of some of the “new” LTCI features that could be offered through CLASS. Many uncertainties remained, however, and we were unable to project the profits that these products would bring in. This came with the territory; we were essentially viewing DHHS as an entrepreneur bringing new products to the market, and entrepreneurship is fraught with uncertainty. When it came time for DHHS to perform the mandated 75 year projection of CLASS profitability, the unpredictable profits from the new products could not offset the certain losses from the base plan.
In retrospect, perhaps this was the best outcome. I could imagine DHHS succeeding as an entrepreneur in the LTCI market, but I would have misgivings. The federal government as business entrepreneur – it almost makes me shiver. Even so, I came away from this experience feeling a little more optimistic about our government. Editorials in the Wall Street Journal and elsewhere applauded the demise of CLASS, arguing that the act was politically motivated and made little economic sense. I will not comment on the political motivations, but I will say that when it came to our contribution to this matter, DHHS officials remained focused on the economic realities.